Europe's Solution isn't More Inflation

We now live in a phony economic world where central bankers rule without check.
Any hint of weakening data, which is actually a sign of reality and healing
returning to the economy, is quickly met with the promise of more disastrous
money printing. Last week we saw U.S. factory orders down and initial jobless
claims rise. In Europe, we saw the Spanish bank bailout fall flat on its face
and interest rates spike in Spain and Italy. Therefore, in predictable fashion,
financial markets soared on the premise that the ECB and Fed must imminently
ride to the rescue once again.

Meanwhile, most Main Stream Economists are auditioning for a role with the
Weather Channel by blaming the persistently weak economic data on a warmer
than typical winter. However, in truth the faltering global economy is resulting
from a massive accumulation of debt that has led to a recession/depression
in Europe. The same situation will inevitably cause a recession in the U.S.,
which will continue to cause a reduction in the growth rate of GDP in emerging
markets.

But an endless increase in central banks' balance sheets can never be the
answer to the malaise we find ourselves in, nor will there be any bailout coming
for Europe other than the viability that can eventually arrive out of a cathartic
depression.

Don't look for Germany to bailout Europe either. The country will never abdicate
its sovereignty to profligate nations and assume the average borrowing costs
of southern Europe on their debt. The U.S. shouldn't advise Germany to adopt
fiscal unity in Europe unless Treasury Secretary Geithner also thinks it's
a good idea to allow Greece the authority to issue T-Bills. Unless they are
given complete control of the PIIGS spending and taxing authority, the Germans
will most likely abandon their parenting role in Europe in due course.

The only real solution for insolvent Europe is to explicitly default on the
debt to a level that brings PIIGS countries to a debt to GDP ratio below 60%.
Then to pass balanced budget amendments and adopt tax and regulation reforms
that makes them competitive with the rest of the world. Also, they need to
adhere to the other strictures of the Maastricht treaty and not fall into the
temptation of abandoning the Euro. Their economies will suffer a short depression,
but this plan is the least painful option.

Having Greece return to the Drachma and defaulting on their debt through devaluation
and money printing is a much worse option. Many are proposing that Greece now
leave the Euro and inflate their way out of debt; just like Argentina did during
2002. However, this ignores the fact that the Argentines first defaulted on
$100 billion of their external debt before removing their currency's peg to
the U.S. dollar. Even though the Peso lost about 75% of its value and caused
a brief bout with high inflation, the Argentine central bank did not have to
monetize its debt. Therefore, the amount of new money printed was greatly reduced
and resulted in a quick rebound in the economy.

In sharp contrast, the Europeans, Japanese and Americans still cling to the
idea that inflation is the answer. PIIGS countries are pursuing an inflationary
default that will increase borrowing costs and lead to a depression that will
be far worse than if they simply admitted their insolvency and defaulted outright.
Devaluing your currency to pay foreign creditors leads to hyperinflation and
complete economic chaos. Paying off your debt by printing money was tried in
Hungary during 1946 and Germany in 1923, but it resulted in complete devastation
and hyperinflation.

If the Eurozone economies persist in the belief that the ECB can restore solvency
to bankrupt nations, the Euro could fall back to parity with the dollar within
the next 16 months. And if such central bank arrogance persists, the Euro could
eventually go the way of the Hungarian Pengo.

Our central bank suffers from the same hubris as its European counterpart.
Bernanke believes a deflationary recession must be avoided at all costs and
that prosperity can be found in a printing press. The U.S. already has a higher
debt to GDP ratio than EU (17) and is growing that debt at an unsustainable
8% of GDP per annum. Therefore, if America doesn't remove her addictions to
borrowing and printing money, our own sovereign debt and currency crisis can't
be more than a few years away.

PPS is a Registered Investment Advisory Firm that provides money management
services and research for individual and institutional clients.

Michael is a well-established specialist in markets and economics and a regular
guest on CNBC, CNN, Bloomberg, FOX Business News and other international media
outlets. His market analysis can also be read in most major financial publications,
including the Wall Street Journal. He also acts as a Financial Columnist for
Forbes, Contributor to thestreet.com and is a blogger at the Huffington Post.

Prior to starting PPS, Michael served as a senior economist and vice president
of the managed products division of Euro Pacific Capital. There, he also led
an external sales division that marketed their managed products to outside
broker-dealers and registered investment advisors.

Additionally, Michael has worked at an investment advisory firm where he helped
create ETFs and UITs that were sold throughout Wall Street. Earlier in his
career he spent two years on the floor of the New York Stock Exchange. He has
carried series 7, 63, 65, 55 and Life and Health Insurance Licenses. Michael
Pento graduated from Rowan University in 1991.